Risks and Opportunities of a Rising China

In the international arena, China poses
a challenge to the United States from a diplomatic, economic, and
military standpoint. Beijing has adopted a strategy that focuses on
the accumulation of strategic resources and the development of a
productive capacity that attracts vast amounts of foreign capital,
modernizes its industry, leaps China's technological base forward,
and strengthens its military. China's diplomacy, especially around
Asia, but also in Africa, Latin America, and Europe, has been a
counterweight to American influence. Being a member of the
Permanent Five of the United Nations Security Council gives China's
economic and diplomatic efforts extra leverage.

For corporations, doing business in
China means navigating the challenges posed by a climate of
cronyism, nepotism, political patronage, counterfeiting, organized
crime, the effect of a dominant, authoritarian political party with
its own internal rules of discipline, and a legal system that
depends on who you know rather than the rule of law. Sometimes, due
diligence means figuring out which Communist Party official can
deliver land and electrical power in return for an American college
education for her son.

The State Security Apparatus

For people used to the rule of law and
open, transparent government, operating in China can be a daunting
experience. In addition to these other problems, the security
professional has to contend with seven or more state-controlled
intelligence and security services that can gather information for
the state-owned industrial sector. These include:

The Ministry of State Security and its local or
regional state security bureaus;

The Public Security Bureau;

The intelligence department of the People's
Liberation Army, or Second Department;

The PLA's Third, or electronic warfare,
Department;

A PLA Fourth Department that focuses on
information warfare;

The technical intelligence collectors of the
military industrial sector and the Commission of Science,
Technology and Industry for National Defense; and

The Communist Party or PLA Political Liaison
Department.

How China Industrialized

Some historical perspective on the way
that China industrialized will help explain the entrepreneurial
approach that China's businesses, military, and intelligence
services sometimes take in acquiring new technology.

Beginning in 1840, British trade
officials and Qing Dynasty imperial administrators disagreed about
free trade. British merchants wanted to sell opium in large
quantities in China, and a Chinese official destroyed three million
pounds of raw opium.

When the Chinese government refused to
compensate British merchants, Admiral George Elliott, the British
negotiator, arrived off Canton with 16 warships and 4,000 troops.
He blockaded the main ports along the Chinese coast. Diplomatic
disputes and military engagements continued through 1842. By June
of that year, British forces captured the ports of Xiamen, opposite
Taiwan, Ningbo, and Zhoushan. The British also took Shanghai and
severed all of China's main river and canal links from north to
south.

On August 29, 1842, the Chinese signed
the Treaty of Nanjing. It opened five Chinese cities for residence
by British subjects, who enjoyed extraterritorial protection for
their property and persons. Those cities were Guangzhou, Fuzhou,
Xiamen, Ningbo, and Shanghai. The Chinese emperor also ceded Hong
Kong to Britain.

It is safe to say that this experience
left a lasting impression on China's imperial family. There was 20
years of internal unrest in China. Ultimately, only foreign
assistance and Western mercenaries helped the Manchu Dynasty
control the unrest. By 1864, China embarked on a
"Self-Strengthening Movement" designed to industrialize the country
and to develop modern arsenals, shipyards, and a strong
military.

Senior Chinese officials sent young
engineers and technicians abroad to study industrial processes,
acquire sets of machine tools, and buy modern weapons. For about
two decades, between 1865 and 1885, Chinese armies and navies
bought the best they could from the international market and then
copied what they were able to in newly built arsenals. The first
ship from the movement was the Tian Zhi, a steam-powered paddle
wheeler that depended on foreign-made engines and propulsion
systems. Its guns came from Britain, Germany, and the United
States. Within two decades, however, Chinese arsenals and shipyards
reverse engineered some of the most modern rifles, cannons, and
guns and produced them domestically.

This all came to a crashing halt between
1884 and 1894. First, in the Franco-Chinese War, in 1884, eight
French warships sank the entire southern Chinese fleet at Ma Wei,
opposite the city of Fuzhou. A disagreement over trading rights in
Vietnam, then a Chinese suzerainty, fueled that dispute. A decade
later, in the Sino-Japanese War, the Japanese Navy and four
infantry divisions put an end to the Self-Strengthening Movement.
They destroyed the Chinese northern fleet, massacred some 60,000
Chinese soldiers and civilians at what is now the city of Dalian,
and took over all of the Shandong and Liaodong Peninsulas. Japan
also took control of the Korean Peninsula and Taiwan in the
settlement of that war.

Three Lessons to Be Learned

I hope you will take three lessons from
this short historical account.

First, the Chinese populace and
government came away from the experience extremely sensitive to
China's sovereignty and to giving foreign firms property and open
commercial rights. To this day, the educational system in China
imparts a big, symbolic cultural chip on the shoulders of Chinese
students about foreign exploitation.

Second, there is a long record in China
of sending government-directed missions overseas to buy or
shamelessly steal the best civil and military technology available,
reverse engineer it, and build an industrial complex that supports
the growth of China as a commercial and military power.

Finally, if Chinese industry failed to
reverse engineer all the components of high-technology goods, they
simply added foreign components to Chinese-produced items.

One can see vestiges of this climate of
the theft of intellectual property and sensitivity to foreign
influence in the newspapers every day. In the political sphere, the
dispute between the Vatican and Beijing is about state control of
ideology and the relationship between belief systems and
politics.

If one follows the arguments in Congress
on how to respond to China's valuation of the Renminbi, the
reluctance to label China a currency manipulator by Treasury
Secretary John Snow is a reaction to the historical chip on the
shoulders of Chinese officials. Snow believes that they will react
better if they are not under direct pressure by a foreign power. In
the economic sphere, the insistence that foreign companies transfer
technology to China is a reflection of this history.

The 863 Program

The same methodical, centrally directed
approach to acquiring foreign technology used in the
Self-Strengthening Movement guides China's programs to gather
industrial and military technology from abroad today. In March
1986, the PRC launched a national high-technology research and
development program with the specific goal of benefiting China's
long-term high technology development. This centralized program,
known as the "863 Program" (or Torch Program), allocates money to
experts in China to acquire and develop biotechnology, space
technology, information technology, laser technology, automation
technology, energy technology, and advanced materials. The "863"
name comes from the month and the year that the program was
proposed.

A few of China's top scientists proposed
the 863 Program as an effort to speed concurrent civil and military
technology development. Like the 19th century Self-Strengthening
Movement, the program sends thousands of students and scientists
abroad to pursue critical civil and military dual-use
technologies.

In 1988, not long after the 863 Program
began, a fellow military attaché and I visited a state-owned
electronics plant in Shandong Province. The plant manager eagerly
took us to the "research lab" to show off the newest product
developed by the factory, a cellular telephone. The lab consisted
of several technicians carefully dismantling Nokia and Motorola
cellular phones and then diagramming and cataloging their parts and
design. There was no sense that industrial designs were being
stolen or that copyrights were being violated. Moving forward to
today, CISCO and the Chinese electronics company Huawei are in a
dispute about whether Huawei copied CISCO routers.

The allegations against Chen Jin, of
Jiaotong University in Shanghai, are an example of the
entrepreneurial approach people take toward industrial espionage
and intellectual property theft in China. Chen returned to China
after earning a Ph.D. at the University of Texas at Austin. In
2003, China treated Chen like a national hero for inventing China's
first signal processing microchip. Last week, Jiaotong University
dismissed him, and Chen stands accused of hiring flocks of migrant
workers with good manual dexterity and great eyesight to scratch
the name "Motorola" off chips and etch in the name of Chen's
company, "Hanxin."

In 2004, the Business Software Alliance
estimated that the U.S. software industry lost $1.47 billion due to
piracy in China. Piracy rates in China remain somewhere between 66
percent and 90 percent across all copyright industries. General
Motors is suing a Chinese automaker for illegally copying the
design of one of its models.

Local governments are also taking an
active role in gathering technology as they build their own
economies. Many provinces and municipalities operate
high-technology zones or "incubator parks" specifically designed to
attract foreign businesses. They also give incentives to bring back
Chinese nationals who have studied or worked overseas in critical
high-technology areas. When entrepreneurs return to China with the
targeted skills, they get free office space, loans, start-up
capital, and administrative help in setting up a business designed
to bring in foreign investment and technology.

The challenge that foreign companies
face is a continuous pressure to disclose or introduce new
technology into China, often as a condition of doing business.
Security professionals have an even greater challenge because of
the weak legal infrastructure and climate of low regard for
intellectual property rights in China. When local employees move to
other companies or open their own businesses, they often take
acquired trade secrets with them.

The efforts of the 863 Program have
largely been successful. China's economy has grown at double-digit
rates for the past 15 years. In the same period, the military
budget has increased by an even greater rate than that of economic
growth. The growth in the military budget often reached 17
percent.

Surprising the U.S. Intelligence
Community

When Beijing fielded two new classes of
submarine last year, the U.S. intelligence community was surprised.
The sophistication of the design was something of a technical
surprise, and the speed of the production process was a strategic
surprise. One of the subs is the nuclear-powered attack Type 094.
The other class of submarine is a nuclear-powered ballistic missile
submarine, Type 093. In addition to these new submarines, today
China has deployed a Xia-class ballistic missile sub, four Kilo
attack submarines bought from Russia, five Han attack subs, seven
Songs, 18 Mings, and 22 Romeos. The last three classes are all
diesel attack submarines.

For a number of reasons, the U.S. Navy
is having a very difficult time tracking Chinese subs, making their
deployment more serious in the Asian defense calculus. The undersea
terrain and ocean characteristics in the Pacific are different from
the Atlantic, making the anti-submarine warfare climate different
in that region from what it was against the Soviets during the Cold
War. In addition, the United States lacks the extensive undersea
listening arrays in the Western Pacific that it had in the Northern
Atlantic. Finally, the Western Pacific is crowded with other ships,
creating a lot of noise that confounds submarine detection.

There are a few other areas where China
now excels in producing military hardware. Besides Russia, only
China can arm its combat ships and aircraft with a hypersonic,
nuclear-tipped cruise missile. China has now fielded a target
acquisition and sensor architecture that will permit cooperative
target engagement by multiple land-, air- and sea-based weapon
systems.

Some of this depended on foreign
technical purchases, but China's defense industries excel in
certain areas. These include cruise missile and ballistic missile
production, missile propellants, and radar signals processing.
China has an active anti-satellite warfare research program going
on. Beijing is working on directed energy weapons like lasers and
millimeter wave weapons as well as advanced kinetic energy weapons.
In the past decade, China has fielded many new surface warfare
ships and combat aircraft.

With foreign help, the PLA has mastered
air-to-air refueling and has fielded airborne early warning radars.
The PLA excels in electronic warfare and has excellent air defense
systems. China has managed to field a large number of
nuclear-capable, mobile short-range missiles and new classes of
intercontinental ballistic missiles with multiple warheads and
maneuvering reentry vehicles.

In some warfare areas, the PLA is having
real trouble. China's military industries cannot master the "hot
sections" of aircraft engines. For some reason, they cannot get
down the metallurgy of jet turbine-engine fan blades. China cannot
produce adequate diesel or gas turbine automotive power trains, so
the PLA needs German or Russian engines for many tanks, missile
transporter-erector-launchers, and armored vehicles. China's
shipyards have excelled in "platform" design and production, but as
in the Self-Strengthening Movement in the 19th century, China still
needs foreign naval engines and propulsion systems, ship
electronics, and fire control systems. They get a lot of this
technology from Europe and Russia.

The picture I have painted for you here
is leading to an explanation of why you can expect to see licensing
restrictions on exports of many defense-related technologies to
China. The tendency in corporations to increase market share in
China and introduce new technology there will pull at security
professionals because of the reticence by the Pentagon and the U.S.
government to permit technology with military application into
China. Congressman Henry Hyde, chairman of the House International
Relations Committee, introduced legislation last year to restrict
European companies from participating in U.S. defense research if
those companies transferred related defense technology to China.
This only postponed the lifting of the European arms embargo on
sales to China, and I expect to see the issue come up again this
fall.

Export Controls in Perspective

China's foreign minister has charged
that if the United States wants to reduce the trade imbalance with
China, it should lift restrictions on high-tech exports.

According to the March 29, 2006,
Revisions of Export and Reexport Controls by the Department of
Commerce, in 2005, United States companies exported $39 billion
worth of items to the People's Republic of China. About $3 billion
of these exports were subject to licensing. That is a rate of
roughly 7.7 percent subject to export licenses. Of the $3 billion
that Commerce reviewed for licenses, the department approved $2.4
billion worth of goods for export and denied the export of $12.5
million worth of goods. The Commerce Department returned the
remaining license applications without action. That means export
licensing stopped only 1.5 percent of the value of exports to
China. Export controls are not keeping our bilateral trade out of
balance.

Still, in the Code of Federal
Regulations (15 CFR 742.4), "there is a presumption of denial for
items that would make a material contribution to the military
capabilities of the People's Republic of China." Among the more
sensitive of the items subject to review are sensors and lasers,
marine propellers and underwater noise reduction software,
propulsion systems, and space vehicles.

Of course, it does not help the case for
increasing high-technology exports to China when its leaders
threaten war against democratic Taiwan. When China's military
leaders threaten to use nuclear weapons on the United States or on
American aircraft carrier battle groups if the U.S. assists Taiwan,
it also reinforces the feeling in Congress that America needs to
retain its own military strength as a potential hedge against
China.

Espionage and Counterespionage

With respect to espionage and
counterespionage, consider two recent cases related to China. In
the Mak case in California, several members of the same family were
arrested and charged with conspiracy to export defense articles and
unlawful attempts to export defense articles. This technology theft
ring focused on acquiring corporate proprietary information and
embargoed defense technology related to the propulsion and
electrical systems of U.S. warships. These included Virginia-class
submarines, quiet electric drive systems for warships, and
electromagnetic catapults for aircraft carrier launch systems.

The espionage effort appears to have
been directed by a Chinese academic at a research institute for
Southeast Asian affairs at Zhongshan University in Guangzhou,
China. The Maks encrypted the information into a computer disk that
also contained television and sound broadcasts. This effort has all
of the earmarks of professional tradecraft and state-directed
espionage, but it could have been industrial espionage out of a
university research institute.

In another case, in Florida, the FBI
arrested a Lockheed employee for trying to export an F-16 engine
and air-to-air missiles to China.

For those who do business in China, it
is often difficult to know whether you are seeing state-directed
espionage, corporate industrial espionage, or just some
entrepreneur out to make a load of money.

The Deputy Undersecretary of Defense for
Technology Security has testified that there are between 2,000 and
3,000 Chinese front companies operating in the United States to
gather secret or proprietary information. The deputy director of
the Federal Bureau of Investigation for counterintelligence
recently put the number of Chinese front companies in the U.S. at
over 3,200. Many of these front companies are the spawn of the
military proprietary companies packed with the families of China's
military leaders.

The nature of the Chinese state
complicates the problem of knowing what the large numbers of
travelers and students from China are actually doing. China is an
authoritarian state led by the Chinese Communist Party. I have
already listed the pervasive intelligence and security apparatus.
The Chinese government is able to identify potential collectors of
information and, if necessary, coerce them to carry out missions on
behalf of the government because of the lack of civil liberties in
China.

When it comes to corporate industrial
espionage, the government owes American companies a good legal
infrastructure to protect trademarks, patents, and copyrights; a
system of education on industrial security; and a strong effort to
ensure that China meets its own World Trade Organization
obligations. The goal should be to create a legal system that
protects ownership rights and intellectual property. However, I do
not believe that American intelligence or security agencies should
focus on forms of economic espionage that do not involve national
security information.

Resource Competition

Another area that is becoming an
increasingly serious economic and security challenge to the United
States is resource competition. The economic growth in China and
its industrial output has created a huge need for natural resources
there. In areas like energy reserves, raw wood products, and the
magnetite used for computer disks, China is willing to pay a
premium to achieve resource security by controlling assets at the
point of origin. This is how 19th century mercantilist states
functioned. For the most part, the Chinese companies involved in
this effort are state-owned. Thus, when they act, they are agents
of the state.

China's efforts to achieve the direct
control of energy resources could lead to disruptions in world
markets and even direct conflict. It is one thing to have a private
company acquire energy or resource rights and then to sell those
resources in the international marketplace. This kind of action can
drive up prices. However, it is still a market-based mechanism.
When states take such actions, those resources are often withdrawn
from the market.

China's actions in the oil and gas arena
have already led to diplomatic friction between Beijing and
Washington. China National Petroleum Corporation invested heavily
in Sudan and takes 50 percent of Sudan's oil exports. Washington
has labeled Sudan a terrorist state. In what appears to be
reciprocity for the oil deal, China blocked the United Nations
Security Council from taking action to stop Sudan's genocidal
practices.

Sinopec, another Chinese oil company,
took a 50 percent stake in a major oil field in Iran and signed a
$70 billion deal to buy Iran's oil and gas over three decades.
Meanwhile, in the U.N. Security Council, China is blocking
international efforts to pressure Iran to accept safeguards on its
nuclear program. Of course, we also worry about China's arms sales
to unsavory governments.

China also has made inroads into
Venezuela, a major oil supplier to the United States. The Chinese
purchase of these assets and of future production without
consideration for human rights or proliferation has increased
Beijing's political influence all around the world. More seriously,
should Beijing ever seek to use its military to back up its
mercantilist acquisitions, it could lead to serious international
conflict.

Conclusion

Our nation faces serious challenges from
China. We have taken a course with China that is far different from
the isolation and confrontational approach we took with the Soviet
Union. Of course, circumstances are different also. China takes
strong positions in the international arena in support of its own
interests. Unlike the Soviet Union, though, it does not seek to
overthrow democratic systems and impose socialist or communist
governments by force.

In a number of areas, our economic and
political relations with China are a success story. China and the
United States share similar interests in open trade, but the
challenge is to ensure that there is an agreed set of rules that
each nation follows. China and the U.S. also share common interests
in ensuring a peaceful international system, but we have very
different approaches to how individual human beings are treated in
that system.

Finally, we have different approaches to
territory and sovereignty, which requires that the United States
still hedge its bets and maintain a strong military.

Larry M. Wortzel, Ph.D., is a former Visiting
Fellow in the Kathryn and Shelby Cullom Davis Institute for
International Studies, and a former Vice President and Director of
the Davis Institute, at The Heritage Foundation. These remarks were
delivered at a conference on "The Asian Century for Business: A
Security Challenge," sponsored by ASIS International and the Center
for Strategic and International Studies and held in Washington,
D.C., on May 23, 2006.

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China and the United States share similar interests in trade butneed an agreed set of rules. They also share common interests inensuring a peaceful international system but have very differentapproaches to how individuals are treated in that system. And theirdifferent approaches to territory and sovereignty require that theU.S. continue to maintain a strong military.

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